Systems A Bright Spot In Mixed Results For IBM

It is hard to describe a company that raked in $18.76 billion in revenues and brought $2.69 billion of that to the bottom as limping along. But watching IBM, as revenues declined by 2.1 percent, after many years of gentle declines, and profits off by 1.3 percent, it sure does feel that way sometimes.

In past years, as Big Blue crested above $100 billion in sales, its growth was limited by its total addressable market among large enterprises that can only get so large, too, as well as by the limits of its imagination for peddling wares to small and medium businesses. IBM lost patience with the volume markets and sold off PCs, printers, and X86 servers, and eventually saw the wisdom of getting out of semiconductor manufacturing, which is a rich company’s game and an extreme volume play at that. This, among other reasons, is why IBM is now an $80 billion company and not a $120 billion company. The idea was to focus at the high end and to generate more value, and that has proved more difficult than Ginni Rometty, IBM’s president and chief executive officer since 2011 and its chairman since 2012, had perhaps anticipated. There were 22 consecutive quarters of revenues declines until last summer, and it looks like it may be starting again.

The good news is that Power Systems did pretty good in the third quarter ended in September. IBM is always vague about how divisions and product lines are doing in terms of sales and profits, but in a conference call with Wall Street last week, Jim Cavanaugh, IBM’s chief financial officer, said that the Power Systems business had a 17 percent revenue spike in the period, which is a big jump – albeit from an easy compare as sales slowed ahead of the Power9 launch, which started in December 2017 and rolled out through August of this year. Now all of the machines are announced, and we will see what the appetite is.

Apparently the appetite for Linux-based Power9 iron is pretty healthy, and Cavanaugh credited Linux with driving a lot of that growth. With the Power E950 midrange and Power E980 high-end NUMA systems launched during the summer, we expect to see IBM turn in a pretty good fourth quarter for Power Systems, although it will be nothing like the bump that Big Blue gets when it trots out a new mainframe workhorse, as happened this time last year with the System z14 mainframes.

Those mainframes are still humming along, and Cavanaugh said that compared to prior mainframe launches in recent years, the System z14 is outstripping its predecessors in terms of aggregate MIPS shipped. In the quarter, System z mainframe sales were up 6 percent and aggregate MIPS shipped rose by 20 percent and set a new record for the amount of performance sold in any quarter. IBM keeps cutting mainframe processing prices to keep customers on the box, so it is tricky to keep the revenue growing with the price chopper coming out all the time, and it is reasonable to wonder where the appetite for mainframe compute will run out. (No market is perfectly elastic, and mainframes are probably more inelastic than many.) If IBM gets too aggressive on price, it will have to renegotiate its wafer agreements with Globalfoundries, the former AMD foundry that also bought IBM Microelectronics and makes the Power and z line of chips for IBM’s machines. The odds seem small, of course. It doesn’t take that many wafers to may the tens of thousands of chips IBM in the high thousands of systems sells in a year. If you believe the numbers from IDC and Gartner.

In the quarter, IBM’s Systems group had $1.92 billion in sales, down 1.6 percent; $1.74 billion of that was sold externally and $181 million of that went to other IBM groups and divisions that sell solutions based on IBM’s own systems. Within this, after doing a little math, we figure that the systems hardware accounted for $1.33 billion in external revenues, up 2.2 percent, and operating systems added up to $406 million, down 3.3 percent. (IBM’s presentations mix as reported revenues with constant currency growth rates, which is annoying as heck.) IBM had $209 million in pre-tax income, which was down quite a bit at 38.3 percent. IBM attributed this to continuing investment in its systems, but we think maybe IBM is having a hard time competing in a cut-throat storage market. Cavanaugh said that storage sales declined for both midrange and high-end arrays, but that flash-based arrays had strong growth. Storage hardware must have taken a pretty good dive to offset the revenue rise for System z and the revenue spike for Power Systems. IBM’s profits were hurt by investment in future processors, systems, and storage as well as a slowdown in licensing of IBM’s intellectual property, which is most lucrative in the semiconductor research area.

Looking ahead, we think IBM’s fourth quarter will be helped by an upgrade cycle for its Power9 NUMA boxes as well as rising uptake of its scale-out Linux machines, which compete head-to-head with systems based on Intel’s Xeon and AMD’s Epyc processors, and probably even cross paths here and there with iron based on Cavium’s ThunderX2 Arm processors. We would very much like to see IBM do something – anything, really – to try to coax the vast base of OS/400 and IBM i shops to get current. There has to be some incentive that will help IBM make some money but not be so expensive that it can’t afford to give customers a good deal. A current base is a healthier base, and will have the processing, memory, and I/O capacity to put more work on their Power Systems machinery. This should be IBM’s top goal, given that the IBM i base is still, after all of these years, its largest customer base.

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